(80 pts) Drones have become more popuiahe purchase more popular in recent years

Question

(80 pts) Drones have become more popuiahe purchase more popular in recent years as commerc drones that would cost $1,650,000. over 3 years. It is ars st $1,650,000. The facility is to be fully depreciated turing fac o cost $500,000 at the end of the project. The co ted ona cilty 's expected to have no resale value at end of 3 years. acility are exoeoxin that final year of operation. Operatina y can ded mvestment of Sain in. No inflation is expected. If the project is underta 9525,00 up cost as an estimated at expected t of $250,000 is e at the time of facility purchase, with full en, a project lifeT Treasury bond rate is a of 1.0. This sury bond rat risk, The market risk premium is 5 percentage points andthe roject hi ongoing profipercent. The corporate tax rate is 34 percent.n ongoing profitable company is all equity financed and has a beta of 1.0 able operations. Should the company undertake the project? a. Estimate the project discount rate. Discount Rate b. What is the initial outlay for the project in year T Initial Outlay $ c. Estimate the operating cash flows from the project for Years T1 through T3 and show them in incoms statement form (ie start with revenues and add/subtract items until you get to CFop. Show all d. Estimate the terminal value cash flow in year 3, if any, (that is, are there any additional cash flowsin addition to the operating cash flow?). Terminal Value ts_ NPV - e. What is the project NPV? ACCEPT or REJECT? Explain Why

Explanation / Answer

a.)     Discount Rate = Risk free rate + Beta*Risk premium {Beta of project is high at 1.5}

= 2% + 1.5*5%

= 9.5%

b.) Initial Outlay = Manufacturing facility purchase + Working Capital Required

= $1,650,000 + $ 250,000

= $ 1,900,000

c.) Calculation of operating cash flows:

(Amount in $)

170,280

So Operating Cashflows: T1 CF=$1,050,280 T2 CF=$1,050,280    T3 CF=$7,20,280

d.) Terminal Cash flows = Working capital surrendered

    = $250,000

e.) Calculation of NPV

PVIF (9.5%)

{Refer PVIF table}

* Year 3 Cash flow = Operating + terminal cashflows = 720,280 + 250,000= 970,280

Accept, the project as Net Present Value is postive. So the project is beneficial to company.

Particulars Year T1 Year T2 Year T3 Revenue 1,833,000 1,833,000 1,833,000 (-) Production Cost 525,000 525,000 525,000 (-) Depriciation {1,650,000/3} (A) 550,000 550,000 550,000 (-) Cleanup cost 500,000 Income 758,000 758,000 258,000 (-)Taxes (34%) 257,720 257,720 87,720 Net Income (B) 500,280 500,280

170,280

Operating Cashflows (A+B) 1,050,280 1,050,280 7,20,280

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